WEALTH HEALTH: Hot market may be burning investors

Investors who are sitting on the sidelines because they believe the market is overdue for a downturn or another calamity will someday be right again. But by doing that, they can spend a lot of quality investment time in the wrong investments.

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By Chuck JaffeFor The Patriot Ledger

The Enterprise, Brockton, MA

By Chuck JaffeFor The Patriot Ledger

Posted May. 4, 2014 at 12:01 AM

By Chuck JaffeFor The Patriot Ledger
Posted May. 4, 2014 at 12:01 AM

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Average investors are known for having a few classic bad habits. Right now, however, they may be avoiding one of those bad traits by actually doing something worse –– pushing investors out of the proverbial frying pan and into the fire.

Consider research released by BankRate.com, showing that nearly three-quarters of Americans say that they are not “more inclined to invest in the stock market right now,” despite the over-sized returns the market delivered last year – and has produced since 2009 – and the under-sized rates they can get on cash and fixed-income investments.

Those numbers held across all ages and income groups, and mirror results from surveys done in 2012 and 2013, when 76 percent of Americans said they were not inclined to increase their stock market exposure.

If you wanted to look at the study and find good news, it’s that the classic poor behavior for investors is that they wait until the market goes up to jump in, and they wind up buying high and selling low. It’s why studies show that investors routinely get the worst out of their mutual funds, rather than the best.performance evens out.

The problem is that by staying out of the market at a point when rates are so low and the Federal Reserve is practically daring you to invest, those same people already have missed out on several great years.

Maybe they locked in the losses suffered during the financial meltdown of 2008, or maybe they simply have stayed put with their asset allocations – in which case not being inclined to invest more in stocks does not suggest they are out of the market – but either way they have missed out on a huge opportunity.

“What money they are squirreling away is overwhelmingly dedicated to those liquid investments; they’re looking to keep money in a savings account or a money market account which is indicative of just how nervous people are,” said Greg McBride, chief analyst at BankRate.com.

The real problem here is that investors are simply exchanging one risk for another, but they think they are being safe in the process.

While the money kept on the sidelines does not face principle risk – the chance they will lose money during a market decline – it runs headlong into purchasing-power risk (the potential for their holdings to be unable to keep pace with inflation) and longevity risk, where current returns are insufficient to make their money last a lifetime.

“People’s feelings haven’t moved, in terms of their aversion to risk in the stock market, but the market has moved,” McBride added. “The stock market’s up 21 percent since last year’s poll was taken. It’s up 35 percent since our 2012 poll was taken. And yet, in all that time, investors’ have not wavered in their risk aversion to the market.

Page 2 of 2 - “This is a little bit different from what we have seen in past cycles where individual investors got scared out of the market in the tech bust, but as the market started to climb back 2004, 2005 and ‘06 they jumped back on the bandwagon,” he added. “Then we had the financial crisis and they got scared out of stocks again, but this time they haven’t come back.”

Scott Wren, senior equity strategist at Wells Fargo Advisors, has long noted that retail customers are sitting on a lot of cash and have been reluctant to put their money back to work in the stock market.“Our clients didn’t buy, they didn’t sell, they sat on their hands and didn’t do anything.”

It would be easy to pass that off as a buy-and-hold, set-it-and-forget-it philosophy, but that’s not what Wren sees as happening.

“Many investors think back not just to the financial calamity that happened in 2008 but also to the tech bubble that burst in 2000 … so 14 years of memories of two times portfolios being down at least on paper over 50 percent have scared a lot of people,” he said. “The baby boom generation is worried about outliving their money but they are sitting on too much cash, and the younger generation … they’re not invested in the stock market I think as much as the baby boom generation was.”

Investors who are sitting on the sidelines because they believe the market is overdue for a downturn or another calamity will someday be right again.

But if you don’t see trouble as being imminent – meaning that an implosion is imminent for reasons that have you scared right now – you can spend a lot of quality investment time in the wrong investments waiting to avoid the next downturn.

Avoiding pain simply because downturns scare you – and with the market at all-time highs, you can make a case that all downturns are “temporary” – too often turns into missing out on the long-term trend. It is, proverbially speaking, jumping out of the frying pan without recognizing that the burn suffered from missing out could be far worse; for too many sideline sitters, the results of seeking too much safety will be worse than the pain they would have suffered by being too aggressive.